Steps Taken to Stimulate the World Economy after World War 1 and World War 2 - Essay Example

Steps Taken to Stimulate the World Economy after World War 1 and World War 2 and the Degree of Success for the Two Approaches By the time the Second World War ended; more than forty million people died from violence and starvation. Both the first and the second world wars left destruction in the economies of the war participants. As such, economic stimuli have to be adopted in a bid to reconstruct the world economy. World War 1 resulted in trade barriers that led to global depression. The United States adopted some plans to stimulate the economy after the war. These included wartime production, central planning and government initiatives. Millions of homecoming soldiers were incorporated into the growing economy. The four main economic controls adopted by the European belligerents and later by America as a latecomer include the food administration, fuel administration, war industries and railroad administration. The duty of food administration was to encourage the production of food and make sure there was equitable distribution among civilians, the allies and the armed forces at a reasonable price. The food and fuel act was put in place to control markups of food processors and distributors (Rockoff, 2010, para 6). Voluntary cooperation at the retail level was encouraged to control inflation, and consumers were urged to reduce their consumption on valuable foodstuffs such as Wheatless Wednesdays. Fuel administration was set to control the price and distribution of bituminous coal resulting from a coal shortage that led to industrial unit closures. The administration of fuel set the price of coal at the mines and dealers’ profits, settled disputes in the coalfield, as well as working with other economic agents like railroad administration to lessen coal lengthy haul. Railroad administration was put in place to help ease the railway network congestion, resulting from delays in the movement of goods for use during the war and coal. The war industries board was responsible for setting prices of industrial based goods like rubber, iron, coal and steel. The America government institutions also gave special attention to business interests, as capital that was held in the private sector due to war uncertainties was made available. The reason is that the government changed its tax policies to support investment. The responsible for Federal Reserve maintained interest at low levels in order to stimulate capital formation for building a large business enterprise in 1919 (Herren, Ruesch & Sibille, 2011, 34;). The American government supported advances in technology which further stimulated the business sector. Farm and industry productivity augmented due to new chemical fertilizers and refinements in the industry, but the aspect of trade barriers after World War 1 led to difficulties in obtaining markets for the increased production in America. In the meanwhile, Europe was struggling to obtain raw materials for its industries, particularly the meal industry. Businesses wanted advertising experts to look for customers, and the economy turned from production oriented to consumer oriented. Financial institutions made loans available, and other businesses extended credit to enhance sales (Knutsen, 1999, p 192). Under the gold standard operation, central banks of individual countries had the ability and restrictions to deal with the effects of flows of gold. The hub of the global finance moved from London to New York. This reduced the economic strength for Britain, which was at centre of international trade before world war one. The gold standard saw countries tie their currencies to gold, where no single individual currency dominated the others. As such, currencies for individual countries were used for world trade and making payments for exports. The international trade helped rebuild the economies of most countries. One of the criticisms of the gold standard is that it was quite unstable since gold reserves were based in the U.S. The instability of the gold standard plunged the world into the great depression and the entire financial system crashed down. The ending of the gold exchange rule and the commencement of the World War II resulted in disarray of the global financial system until after 1945. Employment in factories declined, apparently resulting from layoffs in munitions industries and withdrawal of emergency war employees (Marshall Cavendish Corporation, 2002, p 560). After the Second World War, steps were taken to ensure a more open global economy. That economic order along with technological advances gave rise to new economic growth in many developing countries and the industrialized nations. Recovery for Europe recovery after the Second World War almost came to a stand in 1947. Foreign assets reserves got depleted; earnings on export were inadequate for financing purchases of equipments and raw materials from America, which was the only functioning economy by then. Europe’s earnings were insufficient to offer savings required to finance reconstruction. Taxes were inadequate to support the budget as financial wars and inflation ate into Europe’s ability to reorganize and reconstruct its economy. In order to prevent the European countries from plunging into a humanitarian crisis, the Marshall Plan economic stimulus was adopted. The plan gave resources to finance public expenditure and finance investment, whilst allowing countries to import from the U.S (Beckmann & Simon, 2009, 114). One of the aims of the Marshall plan was to accelerate private investment by offering capital to a poor postwar Europe. Countries that received money invested more in new investments whose returns were high. The plan also offered funds for financing public expenditure on infrastructure. Marshall Plan funds were in the form of hard currency, which enabled Europe to obtain imports in a dollar-scarce world (Barry & Portes, 1989, p, 22). Raw materials for European industries like cotton, coal, petroleum were in acute supply after the Second World War, and the plan made it possible to buy them at a higher rate than would be ordinarily possible. Funds from the plan also made it possible for intra-European trade. Marshall Plan played an essential role in restoring financial stability in the post-second world war Europe. After the First World War, governments responded to inflation by instituting controls, prompting the development of illegal markets. Agricultural producers refused to sell their produce as long as prices were controlled. Farmers were better off hoarding their inventories as proceeds were susceptible to taxation and inflation. The plan helped in the adoption of liberal market solution to decontrol prices, stop inflation and coax producers to bring their products to the market to allow price mechanism to function smoothly (Forrest, 1990, p 48; Michael, 1987, P 103). By contrast, Europe’s external state of affairs seemed more favorable after the First World War, as foreign investments were still large and shipping generated prospective net revenues. Most European nations regained access to the global capital markets after the First World War, unlike in the Second World War when its position to import commodities and draw resources from the entire world was compromised. Following World War II, nations were experiencing challenges in controlling inflation, and most used the gold standard to stabilize their country. However, a global agreement was reached in 1944 with the aim of governing financial policy among nations in order to create a stable global currency, which would ensure financial steadiness once and for all. The agreement reached was to achieve coordination through Bretton woods system that set up the U.S dollar to be the universal currency, thus eliminating the use of the gold standard. Signatories to Breton woods agreement consented to redeem their money and currency for dollars rather than gold. The choice for redeeming the currency using U.S dollar was because three quarters of the global gold supply was held by the United States (Amadeo, 2013, para, 3). The gold standard implied that every country assured that its currency would be bought back by its worth in gold. The Bretton Woods system made the IMF and the World Bank as the main organizations to help supervise the new system. Under the operation of Bretton woods system, signatories agreed that their central banks would preserve a fixed rate of exchange between the dollar and their currencies. This was to be realized by a country purchasing its own currency in the foreign exchange markets whenever its currency value got too low comparative to the United States money. This would in turn lessen the supply that would automatically increase the price. On the other hand, a country whose currency got too high in comparison to the U.S dollar would print more money to increase supply that would lower its price. In order to avoid unfair trade practices, the signatories agreed to avoid any trade rivalry like lowering their currencies severely to increase trade. Nonetheless, countries were allowed to regulate their own currencies whenever foreign direct investment started to flow into their countries in a manner likely to destabilize the financial system. Countries involved in the war were also allowed to regulate their money value after the World War II. The gold standard resulted in hyperinflation because countries could print more currency to cater for their war charges. Runaway inflation resulted since the supply of money exceeded demand. However, during the stock crash of 1929, investors resorted from trading in dollars to commodities, making people to exchange their dollars for gold. This shot up price of gold immensely. The Bretton woods scheme offered countries more elasticity as compared to the gold standard, thus promoting further international trade (Amadeo, 2013, para, 4-6). The Bretton woods resulted in the creation of general agreement on trade and tariffs (GATT), where signatories could import and export to other member countries on favorable terms. This enhanced the global cooperation, which led to the emergence of the world trade organization. The WTO still exists to date and helps in regulating trade practices. As such, Bretton woods system was successful in helping foster economic trade globally, and thus countries were able to attain export led growth through international trade. In conclusion, Marshall Plan was more comprehensive in reconstruction the world after the Second World War as compared to the four elements of food administration, railroad administration, fuel administration and the war industries. Marshall Plan helped the European nations that had been devastated by the war to recover and rebuild their infrastructure and re-establish their trade position globally as the plan entailed more international cooperation. Additionally, the Bretton woods agreement assisted in stabilizing the currencies of signatories before it collapsed. The woods system was more successful as it was finance oriented, and it formed the basis of modern finance that is used up to date. The reason is that most countries today depend on the U.S dollar for stabilizing their currency. The two forms of PPP theory, and the level at which the two forms are valid PPP is a theory regarding exchange and a tool to make more precise comparisons of data between countries. It is a concept of evolution of currencies. PPP assumes that the price for a similar product ought to be the same all over the globe. The theory holds that if a comparison of a similar basket worldwide is made in different currencies, then one ought to have a clue on a currency’s future fluctuation. PPP exchange rate is the rate of exchange between two currencies that would equate the two relevant national price levels if evaluated in a common currency at that rate, such that the buying power of an element of one currency would be similar in both countries. The element of purchasing power parity has two economic applications. First, PPP has a main use as a conversion factor to transfer data from denomination in one national currency to another. The data are mainly in a national accounts framework, though the extent of detail may range from the gross domestic product to more disaggregative classes of expenditure. This usage highlights a body of index number theory and applications in Intercountry comparisons of GDP that have gradually developed over the years. The second use of PPP is the theory of exchange, which has no much widespread acceptance among economists. The reason is that its theoretical usage depends on various assumptions that may not hold in the actual world. Additionally, the quantity of foreign exchange function as a result of exporter and importer demands is much less than the quantity of activity due to investor demands (Michael, 1987, p 233; Sarno &Taylor, 2002, p 68) All parity conditions are founded on the arbitrage basis, which is purchasing an item at a cheaper price in one marketplace and selling it at a higher price in a different market. This law of one price holds that a product selling in a foreign country should sell at a similar price evaluated in the same currency as a product sold domestically. PPP theory states that the equilibrium rates of exchange between two national currencies, not in metallic standard have to equalize the buying power of the two currencies (Shrivastava, nd, p 79; Taylor & Taylor, 2004, p 139). If the U.S dollar buying power is three times that of the Y currency for a similar basket of products and services, then the equilibrium exchange rate ought to be $ 1= 3Y. The PPP theory has been presented in two main forms: the absolute PPP and the comparative/relative form. Absolute form of PPP The absolute form of PPP is founded on the idea that without international barriers; consumers change their demand to wherever prices are lower. It asserts that prices of a similar basket of products in two different countries ought to be equal when weighted in a universal currency. If an incongruity in prices as measured in common currency exists, the demand ought to change in order for these prices to converge. For instance, is a similar basket of products is produced by the united kingdom and the united states, and the price in the united states is lower when evaluated in a universal currency, the demand for that basket ought to increase in the United States and decrease in the United States. Both forces would cause the prices of the baskets to be similar when measured in a universal currency (Blanchard & Quah, 1989, p 657; Woytinsky, nd, p 24). In verity, the presence of transportation costs, quotas, taxes and tariffs may obstruct the absolute form of PPP. If transport costs were high in the above U.K and the U.S example, the demand for a basket of products may not change as suggested. As such, the discrepancy in prices would continue. Absolute PPP holds that the rate of exchange S( expressed in units of domestic money per unit of overseas currency) and the levels of price in the two nations in consideration P ought to be related so that S=P/P*, where P= home price level and P*= the overseas price level. The absolute PPP holds that if the U.S price of a TV set is $ 200 and the rate of exchange S is $0.10 per pound, the price of the TV in U.K should be 200 ($0.10= $ 200/ U.K price). Otherwise, beneficial arbitrage would be possible. Suppose for instance the TV costs 1500 pounds in U.K. As entrepreneurs bought the TVs in U.K, the price will begin to increase on mounting demand. The TVs will be shipped to the United States and traded there, escalating the U.S supply and making the price to decrease. If this happens for enough products and services, the demand for the pound would also rise, eventually increasing the value of the pound. If the TV example was to extend to all products and services, then it would mean that S= index of average prices in the U.S/ index of standard prices in U.K; S= P/P*. If the U.K level of price is 1200 and the United States price level is 120, apparently the rate of exchange ought to be S= 120/1200 giving a rate of $ 0.10. Absolute PPP does not for two countries as a result of the implied assumptions. Absolute theory ignores transport costs and the risks associated with transporting goods globally. It also assumes that consumers in the two countries in consideration do not value the baskets equally (Alesina & Perotti, 1995, p, 963; Bouvier, nd, 6; Taylor, 2001, p 480). Relative PPP The relative form PPP accounts for the possibility of market flaws like transport costs, quotas and tariffs. Relative version of PPP recognizes that as a result of these market flaws, prices of a similar basket of products in different countries will not necessarily be equal when weighed in a common currency. Relative PPP also avoids the implication that the exchange rate is always equal to one since S= P/P*, and the actual rate of exchange has to be 1= (P/P*) × (P*/P). This is untrue as people in different countries purchase products and services in varying proportions. The percentage change in the exchange rate according to relative PPP= %ΔP-%ΔP*, such that the percentage change in the exchange rate for two countries’ currencies equals the differential between the two states’ inflation rates (Taylor, 2001, p 476). Relative PPP states that the rate of change in the prices of a basket ought to be somehow alike when evaluated in a universal currency, as long as barriers to trade and transport costs are not altered. For instance, let’s assume that the U.K and the U.S trade expansively with each other and at first have zero inflation, and another assumption that the U.S experiences a 9 percent inflation rate, whereas the U.K experiences a 4% inflation. In this state of affairs, relative PPP theory holds that the British pound ought to appreciate by about five percent, which is the difference in the inflation rate. Given U.K inflation of 4 percent and appreciation of the pound by five percent, consumers in the U.S will be paying approximately nine percent extra for the U.K products than they paid in the beginning equilibrium state. This is equal to the nine percent increase in prices of U.S goods from the U.S inflation. The rate of exchange ought to adjust to offset the difference in the inflation rates of the two nations such that the prices of commodities in the two states have to appear alike to consumers. The operation behind the comparative PPP hypothesis is that rate of exchange change is essential for the relative buying power to be similar whether in buying products locally or from another country. If the buying power is not the same, customers will change purchases to where products are less expensive awaiting the purchasing power to be equal. For instance, if the dollar appreciated by a single one percent in reaction to inflation (Taylor et al 2005, p 295; Vij, 2006, p 212). In conclusion, absolute PPP differs from relative PPP in that it refers to the equalization of the actual price levels across nations, whilst relative PPP holds that the percentage change in exchange rates, over any period, equals the differential in proportion price changes of different states. As such, relative PPP offers a more realistic view of the exchange rate as it incorporates transport costs and other elements like taxation and quotas assumed by the absolute PPP. Bibliography Amadeo, K. (2013). 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